European Union

Fresh out of the flashing red headline-a-tron:

• IMF OFFICIALS SAY GREECE WILL NEED A THIRD BAILOUT
• IMF SAYS GREECE CAN'T FILL FUNDING GAP ON ITS OWN, UP TO EUROZONE AND ECB TO FIND MONEY FOR GREECE
• GREECE MET ONLY 22% OF PROGRAM TARGETS FOR 2011
• EURO EXIT WOULD SET GREECE BACK BY MANY DECADES

Nobody, NOBODY, could have anticipated that fighting record debt with recorder debt, could possibly fail. And cue Germany telling Greece the party is now over, which, is what (a sliding EURUSD for those confused) it has wanted all along.

After almost forty years on Wall Street we understand both the joke and the punchline and you cannot pay off old debt with vastly greater amounts of new debt without consequences and, we assure you, there will be consequences. This paradigm does not work for a corporation or a sovereign nation and the borrower is eventually brought to his knees by the sheer weight of the debt that he has laden upon his back. The interest rate paid is only part of the equation with the rest being the absolute size of what is undertaken. The Euro and the equity markets rally upon misperception. It is not “unlimited” or “no cap” that are really the operative words for the scheme but the “condition” of use that is the most important part of the recent “Save the World” speech of Mario Draghi. Spain is an admitted user of “dynamic provisioning” which is a long and academic argument for shifting reserves but in the end it means but one thing and one thing only and that is they are admittedly fiddling with their books. Spain is scared to death of the “Obermeisters of the Troika,” the refrains of the three brothers Reich, that will show up in Madrid and demand explanation and sacrifice.

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Unelected bureaucrats, politicians, and bankers

Summary: Today, the German Constitutional Court ruled that the Eurozone’s permanent bailout fund, the ESM, and its ‘fiscal treaty’ on budget discipline do not violate the country’s ‘basic law’ and do not undermine Bundestag sovereignty over budget issues. However, the Court added a cap to the size of the ESM. It also reinforced the effective ‘veto’ of the German Bundestag over ESM activation, and therefore in effect also over a debtor country’s access to the ECB’s bond-buying programme (OMT), since the two are linked. However, the ruling was not unambiguous and in many ways an invitation to further court cases – over ECB bond-buying and others – and a lot more political wrangling. 

MEP Nigel Farage provided a much-needed dose of reality to the peculiar pontifications of Barroso's state of the union speech last night. Concerned at the fanaticism of Europe's ever more concentrated power-base, summed up by his interpretation of Barroso's call for a federal union of states (cue Darth Vader music): "while the nation state should continue to exist, it mustn't have any democratic power," the Englishman goes on to deride Mario Draghi's unlimited money bazooka - though we suspect Farage's belief that "money doesn't grow on trees" will soon come into question day after day.  Super Mario as much as implied that he "will fight to the last German taxpayer to keep the Mediterranean countries, that should never have been in the Euro, in there," but for a sense of just how ludicrous things are becoming in the EU, this clip is important as he reminds us of Monti's (monstrous Mario) recent statement that "nation-state democracy will bring down the European Union." Farage fears this rumbling facade over a crisis could go on for a decade, we can only hope not - one way or another.

Below is an extract of the full statement whose summary kept everyone up this morning, most certainly the headline reacting algos, and which the robots so far seem to like more than dislike.

Last week we discussed what the expectations were for Draghi's OMT - approximately EUR250bn - which coincidentally provided cover for the rest of the year (conditionally) for the entire new issuance of the European Union. Based on EURUSD's recent exuberance - something we saw ahead of QE1 and QE2 - the market is now more than primed for some serious USD debasement. The current EURUSD of 1.2850 implies a Fed-to-ECB balance sheet ratio around 1.11x. If we assume the ECB wil not have to fire its conditional bazooka (of which is priced in 100% likelihood of EUR250bn), then the Fed is expected to conjure a monetization scheme of around USD580bn - anything less would be a disappointment to the market. However, if we assume the ECB will be doing it's bond-buying monetization thing  - as per the equity market's expectations - then the Fed will need to come to the table with a bag of swag around USD850bn in order to debase the USD just enough to regain some hope. It seems like the market has priced in a great deal of monetary policy exuberance  - especially considering how 'confident' consumers appear to be.

There is a Transfer Union underway in Europe. While Germany has tried to avoid this at all costs, Europe, has found a clever way of implementing such a program and keeping it under the radar from the German citizens. In Greece, Spain, Portugal and Italy the ECB has implemented a program where the sovereign guarantees some bank’s bonds. The bank then pledges them as collateral at the ECB and gets cash. The bank then turns around and lends the money back to the sovereign nation and provides liquidity and economic sustenance. The Transfer Union is completed as Germany guarantees 22% of the ECB and the European Central Bank is nothing more than a conduit to lend money to the various nations. This contrivance is also not sterilized so that the ECB is, in fact, printing money. In a very real sense the ECB is the only fully operational part of the European construct at present as the European Union does not have the “political will” to carry out its mandate.

In very real terms the ECB is now no longer an independent institution. The ECB has promised not to act unless the EU assents. The ECB is now totally subject to the whims of the politicians in Europe and whether the markets ignore this for the moment or not that is the truth of it. In promising redemption the ECB has also traded away its ability to act on its own and it will be interesting to see how this plays out.

While illiquid short-dated Spanish bond yields plunge and short-sale-banned Spanish stocks (IBEX) surge back above their 200DMA the most in 16 months, one could be forgiven for falling into the age-old CNBC-trap of "well the market is up so it must be good" belief. Rick Santelli and Mark Grant, in a brief few minutes attempt to get below the surface of the actual words and perception of today's Draghi statement and explain just how the conditionality and size/roll constraints make this supposed unlimited "we'll fix it all" scenario rather ridiculous in that "The ECB is never going to be allowed to do anything." Perhaps just as IBEX fell 17% in 3 weeks after rallying 5.6% on EUR Summit-day hope, we will see some sense of reality sink back in to the circularity of this support.

Several months ago we first suggested that the only outcome of the ongoing antagonism between Germany, the now Goldman-controlled European central bank hell bent on generating inflation at any cost, and the rest of Europe's insolvent states, would be a German referendum in which the German people themsleves are asked what they think of the current mess Europe finds itself in. Naturally, days like today, when the ECB does away with inflationary caution and returns to tried and failed methods - because as a reminder conditional secondary market bond purchases are nothing new, and were last tried in the summer of 2011 when Italy became the latest entrant to the SMP program, and failed - is when the impetus for referendum would be highest. Sure enough, German Spiegel has come out with an article pulling precisely on this increasingly more festering wound for the German population.

One of the primary purposes of a government, any government, is to sustain itself. In its final hours it will do almost anything possible for its self-preservation. While everyone stares at Frankfurt and the last ditch effort of Mr. Draghi there have been other events which are part of this play and merit your attention. Austria has come out and stated quite succinctly that no more Austrian money will be used for other countries; any other countries. Yesterday the Netherlands stated in absolute terms that no more of their money will be used for Greece. If the condition of any ECB funding is to be the approval of the EU and the use of their Stabilization Funds then what Mario Draghi is proposing may never come to pass, may never happen and may just be a rhetorical exercise in wand waving. To us, the world seems askew at present. China is in serious decline, Europe is in a virtual recession as Eurostat releases the numbers today and points to a -0.2% contraction of the EU-17. The markets rally based upon the supposed three Saviors of the world, the central banks of the United States, Europe and China and so the worse that it gets the larger the rally as the central banks will ease and ease again until some kind of wall is hit.

Where is the bacon, Mrs. Clinton?

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